Notice 2008-111 established four required components
for a transaction to be considered an intermediate transaction tax
shelter within the scope of Notice 2001-16.

This article summarizes selected U.S.
federal income tax developments during 2008 affecting corporations,
including those filing consolidated returns. Since the last update,
there has not been any significant legislation specifically directed
at corporations or consolidated taxpayers. However, Congress did
enact several items of legislation, including the Housing and
Economic Recovery Act of 2008 (the Housing Act)1 and the Emergency Economic
Stabilization Act of 2008 (EESA).2 Treasury and the IRS have issued
a number of notices providing short-term guidance about how certain
provisions of EESA and the Housing Act may affect taxpayers. In
addition, the Service and Treasury have issued several packages of
final, temporary, and proposed regulations covering a broad spectrum
of corporate and consolidated issues.

Final and Temporary
Regs.

The Unified Loss Rule

The Service finalized regulations3 under Sec. 1502 that establish an
integrated set of rules, commonly referred to as the unified loss
rule (ULR), for determining the amount of loss, if any, that a
consolidated group recognizes on the transfer of the stock of a
member corporation. The ULR replaces the pre–Rite Aid4 loss disallowance rules of Regs.
Secs. 1.337(d)-1, 1.337(d)-2, and 1.1502-20. The ULR’s principal
purposes are:

To prevent the consolidated return
rules from reducing a group’s consolidated taxable income (CTI)
through the creation and recognition of noneconomic losses; and

To prevent group members from duplicating the tax
benefit of a single economic loss.5

The ULR
generally applies whenever a member (M) transfers a share
of the stock of a subsidiary corporation (S) and the share
is a loss share. For this purpose, the concept of a transfer is
broader than a sale or disposition of the share. The regulations
define a transfer as any event in which:

Certain
nonrecognition transactions are excepted from this definition, and
the regulations incorporate a special rule for intercompany
transfers.

If M transfers a loss share of
S, then immediately before the transfer taxpayers must
sequentially apply three rules to redetermine basis or attributes of
S.

Under Regs. Sec. 1.1502-36(b), each
member’s basis in S shares is subject to redetermination
(the redetermination rule).

If any member’s basis in
a transferred S share is still greater than that share’s
value, that basis is subject to reduction under Regs. Sec.
1.1502-36(c) (the basis reduction rule).

If any
member’s basis in a transferred S share exceeds that
share’s value after application of the prior rules, S’s
attributes are subject to reduction under Regs. Sec. 1.1502-36(d)
(the attribute reduction rule).

Under the redetermination rule, if
M transfers a loss share of S stock, its basis in
all shares of its S stock is redetermined first by reducing
basis in the transferred loss common shares (but not below fair
market value) by the amount of positive investment adjustments
previously applied to the shares and reallocating such adjustments
to other shares. If there is still loss in a transferred S
share (either common or preferred), basis is reduced in such shares
by reallocating negative basis adjustments from common shares that
are not transferred loss shares.7 The regulations provide specific
rules as to how these allocations are to be made. However, the
redetermination rule is not applied if the group disposes of all the
S shares in a taxable transaction or the members have no
gain or loss on S preferred stock and no disparity in their
common stock bases.8

In general, the basis reduction rule
requires M to reduce its basis in the transferred share,
but not below fair market value, by the lesser of (1) the share’s
net positive adjustment or (2) the share’s “disconformity amount.”9 The regulations provide purely
mechanical formulas for calculating a share’s net positive
adjustment and its disconformity amount—no tracing is permitted. 10 As a result, this rule reaches
appropriate results in true “son of mirror” situations but may
improperly allow or deny certain true economic losses.11

Finally, if after the basis
reductions described above the transferred S share is still
a loss share, S’s attributes are reduced (with certain
exceptions) by S’s attribute reduction amount as defined in
Regs. Sec. 1.1502-36(d)(3). The reduction is applied to four
separate categories of S’s attributes in the following
order: (1) capital loss carryovers; (2) net operating loss
carryovers; (3) deferred deductions; and (4) basis of assets other
than Class I assets as defined in Regs. Sec. 1.338-6(b)(1) (e.g., cash).12

The regulations also
establish rules for allocating the reduction among the fourth
category of assets. Regs. Sec. 1.1502- 36(d)(6) allows the common
parent to make an election to avoid or limit attribute reduction by
electing to otherwise reduce members’ bases in the transferred
S loss shares, to reattribute S’s attributes to
the common parent (if S is leaving the group), or some
combination thereof. A taxpayer may make this election protectively
if it is uncertain whether any transferred S share is a
loss share. Informed purchasers may require a protective election to
be filed by the common parent of a selling group in order to
preclude an unintended reduction in the tax attributes of a target
corporation acquired from a consolidated group.

The regulations also include
certain exceptions to the application of these rules as well as an
anti-avoidance provision. Under the anti-avoidance provision,
appropriate adjustments will be made to effect the purposes of the
regulations if a taxpayer acts with a view to avoid the purposes of
Regs. Sec. 1.1502-36 or to apply the regulations to avoid the
purposes of any other rule of law.13

These regulations have been
criticized as overly complex, particularly with respect to the
application of the rules to lower-tier subsidiaries. In addition,
much of the information required to perform the calculations, such
as asset and stock basis, will not be readily available and must be
separately determined. The regulations are generally effective as of
September 17, 2008.14

“Killer B”
and “Killer C” Transactions

On May 23, 2008, the Service issued
temporary regulations15 implementing the rules published
in Notices 2006-8516 and 2007-48.17 Temp. Regs. Sec. 1.367(b)-14T
applies to triangular reorganizations (as described in Regs. Sec.
1.358-6(b)(2) or Secs. 368(a)(1)(G) and (a)(1)(D))
where either the parent (P) or the subsidiary (S)
or both are foreign corporations, and S acquires, in exchange for
property, all or a portion of the P stock that is used to
acquire the stock or assets of the target corporation (T).
Generally, if the regulation applies, adjustments will be made to
have the effect of a deemed distribution of property from S
to P under Sec. 301. The amount of the deemed distribution
is equal to the amount of money plus the value of the other property
transferred by S in exchange for the P stock used
in the reorganization. This distribution is deemed to occur in an
unrelated transaction immediately before the triangular reorganization.18

Moreover, if S acquires
the P stock from a person other than P,
immediately following the deemed distribution P is treated
as contributing to S the property deemed to be distributed
by S to P. If at the time of the purchase P owns S
stock satisfying the requirements of Sec. 368(c), the deemed
distribution and contribution are treated as separate transactions
occurring immediately before the purchase. If P does not
have Sec. 368(c) control of S at the time of purchase, the
deemed distribution and contribution are treated as occurring in
separate transactions immediately after P acquires control
of S. The regulations provide that the deemed distribution
is treated as a distribution of property for all purposes of the
Code and that the deemed contribution, if any, is treated as a
contribution of property for all purposes of the Code.19

The regulations also contain an
antiabuse rule under which appropriate adjustments shall be made if,
in connection with a triangular reorganization, a transaction is
undertaken with a view to avoiding the purpose of the regulations.20The temporary regulations are
generally effective May 27, 2008, but have retroactive application
to four enumerated types of transactions. Furthermore, each
effective date is subject to a limited “binding commitment” exception.21

Complete
Liquidations into Multiple Members

Sec. 332(a) generally
provides that a corporation shall not recognize any gain or loss in
connection with the receipt of property distributed in complete
liquidation of another corporation. As a general rule, Sec. 332(b)
provides that in order to qualify under Sec. 332(a), the recipient
corporation must own stock of the liquidating corporation satisfying
the Sec. 1504(a)(2) requirements (i.e., stock ownership representing
at least 80% of the outstanding voting power and value of the
corporation).

In the separate-return context, this 80%
ownership requirement must be satisfied by a single corporation, but
for members of a consolidated group, Regs. Sec. 1.1502-34 provides
that in determining the stock ownership of a group member in another
corporation, the stock owned by all group members is aggregated.
Therefore, if members of a consolidated group collectively satisfy
the 80% ownership requirement, each member may qualify for
nonrecognition under Sec. 332(a) on the receipt of property
distributed in a complete liquidation.

As a general rule, a complete
liquidation of a subsidiary under Sec. 332 is a transaction to which
Sec. 381 applies,22such that the acquiring
corporation succeeds to and takes into account the items of the
liquidating corporation, including items described in Sec. 381(c),
subject to certain limitations.

While the Sec. 381 provisions are
easily applied in the separate-return context, in which there can be
only one “acquiring” corporation, the Code does not provide clear
guidance on how to apply Sec. 381 in the context of a corporation’s
liquidation into multiple members. The Service issued proposed
regulations in 2005,23 providing a set of rules for the
application of Sec. 381 to these transactions, and recently
finalized the proposed regulations,24 with some modifications,
effective for transactions occurring after April 14, 2008.

As
finalized, Regs. Sec. 1.1502-80(g) provides a system of rules for
determining how the multiple distributee members succeed to items of
the liquidating subsidiary. Note, however, that these rules do not
apply to intercompany items described in Regs. Sec. 1.1502-13. The
allocation of items among the distributee members varies based on
the item category. For example, for income offset items (such as net
operating losses and capital loss carryforwards) and deferred
deductions, each distributee generally succeeds to such items to the
extent they would be reflected in an investment adjustment under
Regs. Sec. 1.1502-32(c) to the stock of the liquidating corporation
owned by such distributee. However, for deferred deductions, as well
as deferred income items, a distributee succeeds to the full amount
of the item if it is attributable to specific property or business
operations acquired by the distributee, provided the item is not
taken into account in the determination of the liquidating
corporation’s income or loss under general tax law principles.

The liquidating corporation’s earnings and profits are similarly
allocated under the principles of Regs. Sec. 1.1502-32(c)— that is,
based on hypothetical investment adjustments to the stock of the
liquidating corporation owned by the distributee. However, each
distributee member succeeds to and takes into account the
liquidating corporation’s tax credits based on the percentage value
of the stock owned by the distributee member and based on the total
value of the liquidating corporation’s stock owned by all members at
the time of the liquidation. Stock of the liquidating corporation
owned by a nonmember is excluded in this determination.

Finally, the regulations include a special rule for the
allocation of “other items” not otherwise described. Generally, if
one of the distributee members directly satisfies the 80% ownership
requirement, it will succeed to all “other items” in accordance with
Sec. 381 and other applicable principles. If no distributee member
directly satisfies the 80% ownership requirement, each distributee
succeeds to the other items to the extent that it would have
succeeded to those items if it had purchased, in a taxable
transaction, the property it received in the liquidation and had
assumed the liabilities it actually assumed in the liquidation.

Matching Rule for Certain Intercompany Gains on
Member Stock

Final and temporary regulations (T.D. 9383)
were issued to provide for the redetermination of an intercompany
gain from the sale of member stock as excluded from gross
income.

Generally, Regs. Sec. 1.1502-13
provides a system of rules that determine the timing and
characterization of items of income, gain, loss, or deduction
arising from transactions between a seller (S) and a buyer
(B) that are members of the same consolidated group. Regs.
Sec. 1.1502- 13(c)(6)(i) provides that, in certain cases,
S’s intercompany item may be redetermined to be excluded
from gross income or treated as a noncapital, nondeductible amount.
However, these cases were previously limited to three situations
specifically enumerated in the regulations.25 Of these, Regs. Sec.
1.1502-13(c)(6)(ii)(C) provided that S’s intercompany item
may be redetermined to be excluded from gross income to the extent
the IRS determines such exclusion is consistent with the purposes of
Regs. Sec. 1.1502-13 and other provisions of the Code and
regulations. The preamble to the final and temporary regulations
refers to this as the “commissioner’s discretionary rule” (CDR).

As stated in the preamble to the regulations, the Service has
received ruling requests for the application of the CDR to determine
that S’s gain with respect to a member’s stock should be
excluded from gross income. In considering these requests, the IRS
concluded that the principles guiding the CDR’s application were not
clear enough to justify the redetermination of such gain as
excludible. However, the Service did identify at least one
additional situation involving intercompany gain on member stock for
which it is appropriate to permit exclusion of such gain, and the
new temporary regulations were issued to add this new exception. The
new regulations redesignate the CDR as Regs. Sec.
1.1502-13(c)(6)(ii)(D) and add the new exception as Temp.
Regs. Sec. 1.1502-13T(c)(6)(ii)(C).

Temp. Regs. Sec.
1.1502-13T(c)(6)(ii)(C) provides that intercompany gain with respect
to member stock is redetermined to be excluded from gross income to
the extent that:

The gain is the intercompany item
of the group’s common parent (P);

Immediately before the intercompany gain is taken into
account, P owns the member stock for which the
intercompany gain was realized;

P’s basis in such stock is eliminated without the
recognition of gain or loss (and such eliminated basis is not
further reflected in the basis of any successor asset);

The group has not and will not derive any U.S. federal income
tax benefit from the intercompany transaction that gave rise to
the intercompany gain or the redetermination of such gain
(including basis adjustments under Regs. Sec. 1.1502-32); and

The effects of the intercompany transaction have not
previously been reflected, directly or indirectly, on the group’s
consolidated return.

While favorable to taxpayers,
this new exception is narrowly tailored and does not provide relief
for situations that do not fall squarely within the criteria set
forth above. For example, a deferred gain from the sale of stock of
a wholly owned foreign subsidiary does not satisfy the new exception
because the foreign corporation is not a member.

Furthermore,
based on language in the preamble and informal discussions with the
Service, the author believes that with the addition of this limited
exception, the IRS is unlikely to respond to ruling requests for the
application of the CDR to situations not specifically covered by
this exception.

Proposed Regulations

Outbound Asset Transfers Under Secs. 367 and 1248

On August 19, 2008, the Service
issued proposed regulations under Secs. 367, 1248, and 6038B26 regarding certain outbound
transfers of property under Sec. 361. The proposed regulations also
clarify certain conditions for the application of the coordination
rule exception in Regs. Sec. 1.367(a)-3(d)(2)(vi)(B).

Sec. 367(a)(5): In general, Sec. 367(a)(5) provides that
Sec. 361 exchanges remain subject to Sec. 367(a)(1) and that the
nonrecognition exceptions in Secs. 367(a)(2) and (a)(3) do not
apply. As a result, under the general rule of Sec. 367(a)(5), a U.S.
transferor is required to recognize gain on the transfer of
appreciated property to the foreign acquiring corporation in a Sec.
361 exchange. However, Sec. 367(a)(5) also provides that, subject to
basis adjustments and such other conditions as provided in the
regulations, this general rule does not apply if the U.S. transferor
is controlled (within the meaning of Sec. 368(c)) by five or fewer
domestic corporations.

Before the issuance of these proposed
regulations, neither Treasury nor the Service had issued any
guidance on the application of the basis adjustment exception in
Sec. 367(a)(5). Prop. Regs. Sec. 1.367(a)-7 sets forth an elective
exception to the general rule of Sec. 367(a)(5) under which a U.S.
transferor may avoid the recognition of gain in an outbound Sec. 361
exchange if the transfer satisfies four conditions and requirements,
discussed below. Generally, the proposed regulations apply to all
property transferred in a Sec. 361 exchange other than property to
which the provisions of Sec. 367(d) apply.

First, the U.S. transferor must be
directly controlled (within the meaning of Sec. 368(c)) by five or
fewer domestic corporations, excluding regulated investment
companies, real estate investment trusts, and subchapter S
corporations (the control group).27 Indirect ownership by a
domestic corporation through a partnership or other entity is not
taken into account.

Second, the U.S. transferor must
recognize gain equal to the aggregate amount of the inside asset
gain allocable to noncontrol group members.28 This gain is allocated among
the control group members based on the respective ownership
interests in the U.S. transferor, measured by value, at the time of
the exchange. In addition, the U.S. transferor must recognize gain
to the extent that any member of the control group is unable to
preserve its share of the “inside gain” in the basis of the stock it
receives in the exchange. The regulations provide formulas for
determining the inside gain, the amount of inside gain that cannot
be preserved, and the amount of stock allocable to Sec. 367(a)
property (the Sec. 367(a) percentage).29

Third, Prop. Regs. Sec.
1.367(a)-7(c)(3) requires each control group member to reduce its
basis in the stock it received in the Sec. 361 exchange to the
extent necessary to preserve its share of the inside gain. The
proposed regulations, as initially issued, provided that the
appropriate basis reduction was equal to the amount by which the
member’s share of inside gain exceeded the built-in gain in such
stock (i.e., the outside gain). However, a subsequent technical
correction to the proposed regulations clarifies that the basis
reduction is equal to the amount by which the inside gain exceeds
the outside gain or loss in such stock.30 If a control group member holds
separate blocks of stock, the basis in each block must be reduced
pro rata according to the relative basis of each block of stock.31 Finally, the U.S. transferor
must file a statement with its income tax return for the year of the
exchange certifying that if the foreign acquirer disposes of a
“significant” amount of the assets it acquired in the Sec. 361
exchange in one or more transactions entered into with a principal
purpose of avoiding the U.S. tax on the inside gain, then the U.S.
transferor must file a tax return (or amended return) for the year
of the exchange reporting the gain realized, but not recognized, on
such exchange.32

In addition, the U.S. transferor
and each control group member must enter into a written agreement to
make an election to apply the regulatory exception. The agreement
must include certain information specified in the proposed regulations.33

Secs. 367(b) and 1248(f ): Under Sec. 1248(f), except as
provided in regulations, a domestic corporation that transfers the
stock of a foreign corporation of which it is a Sec. 1248
shareholder in certain distributions, including under Secs. 355(c)
or 361(c), is required to include the Sec. 1248 amount for the stock
in income as a dividend.

Under the current regulations, in
certain circumstances the Sec. 1248 shareholders may avoid a current
income inclusion if the Sec. 1248 amount attributable to the foreign
stock may be preserved. However, current regulations also provide
that if a Sec. 1248 shareholder of a foreign acquired corporation
transfers the stock of such corporation to a foreign acquiring
corporation in a Sec. 361 exchange, that shareholder must include in
income the attributable Sec. 1248 amount, even if the foreign
acquiring and foreign acquired corporations are controlled foreign
corporations (CFCs) for which the transferor continues to be a Sec.
1248 shareholder immediately after the exchange.34

The proposed
regulations alter the latter result. Generally, they would require
the U.S. transferor to include in income the Sec. 1248 amount only
if, immediately following the Sec. 361 exchange, either the foreign
acquiring or the foreign acquired corporation is not a CFC with
respect to which the U.S. transferor is a Sec. 1248 shareholder. The
proposed regulations modify Regs. Sec. 1.367(b)-4(b)(1)(iii),
Example (4), accordingly. The proposed regulations also provide for
certain adjustments to the basis of the foreign acquiring stock
received in the transaction, as well as the earnings and profits
attributable to such stock, in order to fully preserve the
application of Sec. 1248. In addition, the proposed regulations make
similar changes to the current regulations with respect to a
transfer of foreign acquired corporation stock to a foreign
acquiring corporation in a Sec. 361 exchange that is part of a
triangular asset reorganization.

The proposed regulations
under Sec. 1248(f) provide a general rule that if a domestic
corporation distributes the stock of a foreign corporation for which
it is a Sec. 1248 shareholder either under Sec. 337 or in a
nondivisive Sec. 355 distribution, the domestic corporation is
required to include in its income the Sec. 1248(f) amount from the
distributed foreign stock. The regulations also set forth exceptions
to this general recognition rule, including an irrevocable elective
exception for certain Sec. 355 distributions that may require
adjustments to the basis and holding period of the distributed stock
in the hands of the Sec. 1248 distributee.

Elections for Qualified Stock Dispositions

Sec. 336(e) was enacted by the Tax
Reform Act of 198635 as part of the repeal of the
General Utilities doctrine36 and is intended to provide
taxpayers with a means of avoiding potential multiple taxation of
the same economic gain. To that end, Sec. 336(e) provides that,
under regulations prescribed by the IRS, if a corporation (the
seller) owns stock in a subsidiary corporation (the target)
satisfying the ownership requirements of Sec. 1504(a)(2) and sells,
exchanges, or distributes all the stock, the seller may elect to
treat such sale, exchange, or distribution as a sale of the target’s
assets.

Based on the statutory language,
the Service does not consider Sec. 336(e) to be self-executing. To
provide taxpayers with the requirements and methodology for making a
Sec. 336(e) election, Treasury issued proposed regulations
authorizing Sec. 336(e) elections for certain transactions.37 Generally, these proposed
regulations provide an election to treat certain stock dispositions
that are not otherwise eligible for a Sec. 338 election as deemed
asset sales. However, the election is not available for dispositions
of stock to related parties or for dispositions in which either the
seller or the target corporation is foreign.

The proposed regulations adopt
mechanics for a Sec. 336(e) election analogous to those that apply
in the case of an election under Sec. 338(h)(10), but the Sec.
336(e) election applies to dispositions to both corporate and
noncorporate shareholders. Under Prop. Regs. Sec. 1.336-2(a), a
seller may make a Sec. 336(e) election if it disposes of a target’s
stock in a qualified stock disposition (QSD). For this purpose, a
QSD is generally any transaction or series of related transactions
under which the target’s stock meeting the requirements of Sec.
1504(a)(2) is sold, exchanged, or distributed within a 12-month
period. A QSD also includes a distribution qualifying under Sec. 355
but for which the distributing corporation is required to recognize
gain under Secs. 355(d)(2) or (e)(2).38

Under the general rule, if an
election is made, the old target is treated as selling its assets to
an unrelated person in exchange for the aggregate deemed asset
disposition price (ADADP) determined under Prop. Regs. Sec. 1.336-3.39 The old target realizes the tax
consequences of this deemed disposition while still owned by the
seller. The old target is then deemed to transfer all of its assets
to the seller before the close of the disposition date.40 This transfer will generally be
treated as a distribution in complete liquidation of the seller.

Similarly, the new target is deemed
to have acquired the old target’s assets in a single transaction
from an unrelated seller in exchange for an amount equal to the
adjusted grossed-up basis (AGUB) determined under Prop. Regs. Sec. 1.336-4.41 Both the ADADP and the AGUB are
allocated among the assets under the principles of Sec. 338. The new
target also remains liable for the old target’s tax liabilities. In
the case of elections for multiple tiers of subsidiaries, the
proposed regulations provide that the deemed asset sales and the
deemed asset purchases occur in a “top-down” and “bottom-up”
sequence, respectively, as in the case of a Sec. 338 election for
tiered entities.

In the case of a stock
distribution, the seller is then deemed to have purchased from the
new target on the disposition date the amount of stock distributed
in the QSD and to have then distributed such stock to its
shareholders in a transaction in which the seller recognizes no gain
or loss. If the seller retains any target stock, it is deemed to
have been purchased on the day after the disposition date for an
amount equal to its fair market value.42

The Sec. 336(e) election is a
unilateral election available only to the seller. The proposed
regulations establish the manner for making the election. Moreover,
the proposed regulations clearly provide that sellers may make
protective Sec. 336(e) elections that will have no effect if the
transaction does not constitute a QSD but that are otherwise binding
and irrevocable.43 The availability of a
protective election is particularly useful for a Sec. 355
distribution that is subject to Secs. 355(d) or (e), where the event
that gives rise to the application of Secs. 355(d) or (e) (thus
resulting in a QSD) may not occur until several months after the
disposition date.

Rulings and Publications

Intermediate Transaction Tax Shelters

In Notice 2001-16,44 the Service identified a
category of listed transaction known as an intermediary transaction
tax shelter (ITTS), commonly referred to as a “midco” transaction.
The notice describes the typical ITTS transaction as involving four
parties: a seller (X) that wants to sell stock of a
corporation (T), an intermediary (midco) corporation
(M), and a buyer (Y) that desires to purchase the
assets (and not the stock) of T. Under an integrated plan,
X sells the T stock to M, and T
then sells some or all of its assets to Y. Y claims a basis in the
T assets equal to Y’s purchase price, but either M
or T offsets or is not required to report the gain (or tax)
resulting from T’s sale of assets. Thus, X is subjected to only a
single level of tax on the sale of T, but Y
obtains a stepped-up basis in the T assets with no tax cost
to X, M, or T. The notice states that
transactions the same or substantially similar to such a transaction
are also listed transactions but provides no additional guidance.45

Notice 2008-11146 modifies Notice 2001-16 by
providing that a transaction will be treated as an ITTS with respect
to a particular person only if the transaction includes four
objective components, the person participates in the transaction as
part of a plan, and none of the three safe-harbor exceptions in the
notice applies to the person. The four objective components are:

T (the target corporation) directly or indirectly (e.g.,
through a passthrough entity) owns assets, the sale of which would
result in taxable gain. As of the time of the stock disposition
described in component 2, T (or its consolidated group)
has insufficient tax benefits to eliminate or offset such taxable
gain, or the tax, in whole (the built-in tax).47

At least 80% of
the T stock (by vote or value) is disposed of by
T’s shareholder(s) (X), other than in
liquidation of T, in one or more related transactions
within a 12-month period.

Either within 12 months
before, simultaneously, or within 12 months after the date on
which X has disposed of at least 80% of the T
stock (by vote or value), at least 65% (by value) of T’s
assets are disposed of (sold T assets) to one or more
buyers (Y) in one or more transactions in which gain is
recognized with respect to the sold T assets.
Transactions in which T disposes of all or part of its
assets to either another member of the controlled group of
corporations of which T is a member or a partnership in
which members of such controlled group satisfy the requirements of
Regs. Sec. 1.368- 1(d)(4)(iii)(B) will be disregarded provided
there is no plan to dispose of at least 65% (by value) of the sold
T assets to one or more persons that are not members of
such controlled group or such partnerships.

At least
half of T’s built-in tax described in component 1 that
would otherwise result from the disposition of the sold T
assets described in component 3 is purportedly offset, avoided, or
not paid.

A person engages in the transaction
pursuant to a plan if the person knows or has reason to know the
transaction is structured to effectuate the plan. Additionally, any
X that is at least a 5% shareholder of T (by vote
or value), or any X that is an officer or director of
T, engages in the transaction pursuant to a plan if certain
officers or directors of T or advisers engaged by
T or X know or have reason to know the transaction
is structured to effectuate a plan. The scope of the term “plan” is
not well defined, but the notice does provide three safe harbors for
transactions that are not an ITTS with respect to certain of the
participants.

Thus, a transaction may be an ITTS with respect
to X but not Y, with respect to Y but not
X, or with respect to some but not all Xs and/or
some but not all Ys, depending on whether they engage in
the transaction pursuant to the plan. A transaction will not be an
ITTS with respect to any person that does not engage in the
transaction pursuant to a plan regardless of the amounts reported on
any return.

The new rules in Notice 2008-111 represent a
significant improvement over Notice 2008-20, which did not include a
plan requirement and merely focused on whether a transaction
included the four objective components. Because the previous notice
did not include a plan requirement, it was possible that a person
could inadvertently participate in a transaction considered to be an
ITTS if the transaction met the four objective requirements. The
inclusion of the plan requirement in Notice 2008-111 significantly
limits the scope of Notice 2001-16, but does not completely preclude
the possibility that certain nonabusive transactions might be
treated as an ITTS.

Reverse Subsidiary Merger
Followed by Liquidation of Target Fails to Qualify as a Reorg.

On May 8, 2008, the Service issued
Rev. Rul. 2008-25,48 addressing the income tax
consequences of a transaction in which, under an integrated plan, a
parent corporation (P) acquires all the stock of a target
corporation (T) in a reverse subsidiary merger and then
completely liquidates T into P in a nonmerger
liquidation.

The step-transaction doctrine is
not applied to integrate a taxable stock purchase followed by a
liquidation of the target as an acquisition of the target’s assets49 because Congress has explicitly
provided that an election under Sec. 338 is the only means by which
a taxable stock purchase may be treated as an asset acquisition for
federal income tax purposes. However, the Service has also ruled
that the policy underlying the exclusivity of Sec. 338 is not
violated by integrating a stock acquisition and subsequent
liquidation of the target to treat the transaction as an acquisition
of the target’s assets if the integrated transaction qualifies as a
nontaxable reorganization.50

In Rev. Rul. 2008-25,
an individual (A) owns all the stock of a corporation
(T) having assets worth $150x and $50x of liabilities.
P, a corporation unrelated to A and T,
with net assets of $410x, wishes to acquire the T stock.
P forms corporation X, a wholly owned subsidiary,
for the sole purpose of acquiring the T stock by causing
X to merge with and into T in a statutory merger,
with T surviving. In the merger, A exchanges the
T stock for $10x in cash and P voting stock worth
$90x. Following the merger and under an integrated plan that
includes the merger, T completely liquidates into
P, transferring all its assets and liabilities to
P. The liquidation of T is not accomplished
through a statutory merger. After the liquidation, P
continues to conduct the business previously conducted by
T.

The Service notes that, treated separately, the
merger should qualify as a reorganization under Sec. 368(a)(1)(A) by
reason of Sec. 368(a)(2)(E), and the liquidation should qualify as
tax free under Sec. 332. However, Regs. Sec. 1.368- 1(a) provides
that a transaction must be evaluated under relevant provisions of
law, including the step-transaction doctrine, in order to determine
whether it qualifies as a Sec. 368 reorganization. In the present
case, because T completely liquidates, the safe harbor of
Regs. Sec. 1.368-2(k) (precluding application of the
step-transaction doctrine) does not apply. As such, the merger and
liquidation cannot be analyzed separately and the transaction fails
to qualify as a reorganization under Sec. 368(a)(1)(A) by reason of
Sec.368(a)(2)(E) because T does not hold substantially all
of its properties and the properties of S after the transaction.

Moreover, P’s acquisition
of T’s assets does not qualify as a reorganization under
any other provision of the Code. Unlike the transaction described in
Rev. Rul. 67- 274, in this transaction the consideration provided in
exchange for T’s assets does not consist solely of
P voting stock, and the “boot relaxation rule” of Sec.
368(a)(2)(B) is not satisfied.51 Furthermore, because the
liquidation of T is not completed via a statutory merger,
the recast transaction does not qualify as a reorganization within
the scope of Sec. 368(a)(1)(A). In addition, P’s acquisition of the
T stock in the merger is not a Sec. 351 transaction because
A does not have Sec. 368(c) control of P
immediately after the exchange.

Because the integrated
transaction does not constitute a Sec. 368 reorganization, Rev. Rul.
90-95 and Regs. Sec. 1.338-3(d) reject the application of the
step-transaction doctrine and treat P’s acquisition of
T as a qualified stock purchase within the scope of Sec.
338, with the subsequent liquidation of T constituting a
complete liquidation of a controlled subsidiary under Sec. 332.

Guidance Under EESA and the Housing Act

The
Service has issued several notices regarding the application of the
loss limitation provisions of Sec. 382 to certain of the
transactions arising out of the passage of the Housing Act and
EESA.

Notice 2008-76

The Housing Act granted Treasury
the authority to purchase securities to be issued by Freddie Mac and
Fannie Mae. In Notice 2008-76,52 the IRS and Treasury announced
their intention to issue new regulations under Sec. 382(m) under
which the definition of “testing date” will be modified to exclude
any date on or after which the U.S. government (or any agency
thereof) acquires certain stock or options in Freddie Mac or Fannie
Mae under the Housing Act. The regulations will be effective for
transactions occurring on or after September 7, 2008. This
modification will preclude potential ownership changes of Freddie
Mac or Fannie Mae as a result of these investments because there
cannot be an ownership change without a testing date. Absent this
provision, an ownership change could severely limit the loss
carryforwards or net unrealized built-in losses of Freddie Mac or
Fannie Mae.

Notice 2008-84

In Notice 2008-84,53 the Service announced that
regulations will be issued to address the application of Sec. 382 to
certain acquisitions not described in Notice 2008-76, namely, any
acquisition by the U.S. government (or any agency thereof), directly
or indirectly, of a more-than- 50% interest in any loss corporation.
For this purpose, a more-than-50% interest is stock possessing (1)
more than 50% of the total value of the corporation (excluding stock
described in Sec. 1504(a)(4)) or (2) more than 50% of the total
combined voting power of all classes of voting stock. The definition
also includes an option to acquire such a stock interest.

The
regulations to be issued will operate in similar fashion to those
described in Notice 2008-76, by amending the definition of “testing
date” to exclude any date as of the close of which the United States
directly or indirectly owns a more-than-50% interest in a loss
corporation. Note, however, that any owner shifts occurring during
this period may be relevant for testing during the periods after
which the United States no longer owns a more-than-50% interest.

Notice 2008-83

Notice 2008-8354 provides that for purposes of
Sec. 382(h), solely with respect to a loss corporation that is also
a bank (as defined in Sec. 581), any deduction properly allowed
after a Sec. 382 ownership change with respect to losses on loans or
bad debts shall not be treated as a pre-change builtin loss or
deduction. Thus, these items will not be subject to the Sec. 382
limitation that would otherwise apply to pre-change losses. Banks
are entitled to rely on the provision of this notice unless and
until additional guidance is issued. This notice is strictly limited
to deductions attributable to banks and does not include any
deductions of nonbank affiliate entities.

Notice 2008-78

In Notice 2008-78,55 the Service announced that it
will issue regulations regarding the application of Sec. 382(l) to
loss corporations. Generally, these regulations will provide that
notwithstanding Sec. 382(l)(1)(B), a capital contribution to a loss
corporation during the two-year period ending on the date of an
ownership change shall not be presumed to be part of a plan having a
principal purpose of avoiding or increasing a Sec. 382
limitation.

Instead, the determination of whether such a
contribution is part of a plan will be made on the basis of all
relevant facts and circumstances, applying principles similar to
those set forth in Regs. Sec. 1.355-7. In addition, the notice
establishes four safe harbors for certain types of contributions. It
provides that taxpayers may rely on the rules described therein for
any ownership change that occurs in a tax year ending on or after
September 26, 2008, unless and until there is additional
guidance.

These notices are likely to be followed by additional
published guidance covering other bailout-related issues,
particularly as additional legislative action is taken.

EditorNotes

Brandon Hayes is a senior manager, National
Tax M&A/ Transaction Advisory Services, at Ernst & Young LLP
in Washington, DC. For more information about this article, contact
Mr. Hayes at brandon.hayes@ey.com.

Author’s note:

The views expressed herein
are the author’s alone and do not necessarily reflect the views of
Ernst & Young LLP.

11 A “son of mirror” transaction occurs
where loss on the sale of a consolidated subsidiary’s stock
can be attributed to recognition of built-in gain on the
disposition of an asset (i.e., the gain is already reflected in the
stock’s basis before the asset’s disposition).

36 The General Utilities doctrine allowed
a C corporation to make a tax-free liquidating distribution to its
shareholders prior to a sale of the company (General Utilities &
Operating Co. v. Helvering, 296 U.S. 200 (1935)).

47 In determining whether T’s (or the
consolidated group’s) tax benefits are insufficient for these
purposes, these tax benefits are excluded: (1) any tax benefits
attributable to a listed transaction under Regs. Sec.
1.6011-4(b)(2), and (2) any tax benefits attributable to built-in
loss property acquired within 12 months before the stock disposition
described in component 2, to the extent such built-in losses exceed
built-in gains in property acquired in the same transaction(s).

51 The total consideration provided in the
merger consists of $10x in cash, $90x in P voting stock, and $50x of
assumed liabilities that must be treated as boot due to the issuance
of $10x in cash. Thus, only 60% of T’s assets ($90x ÷ $150x)
are acquired in exchange for P voting stock.

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